Evaluation: How am I doing?

[psuicyde king]

Jim - any advice on creating a will? I'm an online do-it-yourselfer as often as possible, though I want to make sure that's a safe route for this will.

[jpg7n16]

I realize I'm not Jim (and I'm not an attorney), but best option is to see an estate attorney.

Estate Planning Mistakes Lawyer St. Paul MN | Power of Attorney Minnesota Minneapolis

[psuicyde king]

I realize I'm not Jim (and I'm not an attorney), but best option is to see an estate attorney.

Estate Planning Mistakes Lawyer St. Paul MN | Power of Attorney Minnesota Minneapolis

Good advice - thank you, jpg!!

[bjl584]

Why are you renting a house out and then renting an apartment for yourself? Unless I'm reading that wrong. Would it be possible to just live in the house that you are renting and get rid of the apartment?

[jIM_Ohio]

everything else is good though? i.e. no concerns about save/spend rate or anything?

I itemized the expenses and income, but never compared

I also see this in one of early posts

I'm trying to save about 4k per month. I just took a position which is high-risk/high-reward. It's possible that I'm out of a job later this year, though I'm confident I could grab a 6-figure salary fairly quickly, especially if I'm willing to relocate.

If you think you might lose job, try banking 1 months expenses per month

Quote:
1) total monthly expenses and total yearly expenses for self
* monthly:
rent: 1700
cell phone: 100
cable tv: 50
car: 300
airline tickets (long distance relationship): 400
food: 300
* annual:
sports season tickets: 2,000
performing arts tickets: 2,000

1a) do the same for rental (mortgage costs and taxes)
800/month (recovered with 800/month rent from tennant) - taxes included in the payment
monthly expenses are $3300 per month (I added $2000+$2000 then divided by 12 for just over $300/mo)
monthly rental expenses are $800/mo

Meaning if you spend $3300 and have $4000 to save, with expectation of losing a job, I would bank $1 for every $1 spent, then invest or spend the $700 difference.

Hedging bets... once you have savings of about 2 years expenses (which would take you 2 years to accumulate) you can invest more for long term.

[psuicyde king]

Why are you renting a house out and then renting an apartment for yourself? Unless I'm reading that wrong. Would it be possible to just live in the house that you are renting and get rid of the apartment?

I moved to another state for personal reasons and was unable to sell the house when I moved. After some time, I decided to rent it out. My initial preference was to sell, not rent. Right now I'm trying to determine whether to re-list it for sale, or to shift my mindset to rental as a long-term investment.

[jIM_Ohio]

I moved to another state for personal reasons and was unable to sell the house when I moved. After some time, I decided to rent it out. My initial preference was to sell, not rent. Right now I'm trying to determine whether to re-list it for sale, or to shift my mindset to rental as a long-term investment.

If this is a long term invesment, I would do the following

1) raise the rent- $100/mo profit, which is all going to principal, is hardly a good return on investment unless you document to me otherwise.

2) cash out all equity in the property. You can write off interest on taxes, but not payments to principal. If property is damaged, you have less risk if you have no money down or low equity in the property.

3) look to add more properties to spread the risk around a little bit (this one property would have a decent amount of return and risk and net worth to you... minimize the bad parts of the risks by owning more properties.

[jpg7n16]

...2) cash out all equity in the property. You can write off interest on taxes, but not payments to principal. If property is damaged, you have less risk if you have no money down or low equity in the property.

I disagree with that one.

Yes - you get to write off interest on taxes, and yes - you do not write off principal payments. But you don't pay interest on equity. So if you have a home worth $100k- say your two options are a $100,000 interest-only mortgage @ 5% (would maximize interest vs principal) or no mortgage. And say you're in the 25% bracket...

The rental income would be the either way, so it doesn't matter, but:

Mortgage, you'd pay $5000 in interest, and write that off on taxes to save $1250. Net Loss = $3750.
Paid for rental: you'd pay $0 in interest, and write off $0 to save $0 on taxes. Net loss = $0

Losing $0 is better than losing $3750.

If the property is damaged, you have the same risk either way. The amount of loan held against a property has no impact on its market value. If the property is damaged, you lose the same either way. Get homeowner's insurance

But if the property is vacant - there is actual risk with a mortgage, and no real risk with a paid for property. You still have to make the mortgage payment if it's vacant, so the impact of vacancy is magnified when there is a loan.

Loans make leverage. Leverage increases risk.

[psuicyde king]

My default answer right now is to try to sell the property. The current tenant has showed interest, so maybe work with him more on a purchase. I don't have a desire to keep it as a long-term investment unless there's an obvious reason to do it.

[jIM_Ohio]

I disagree with that one.

Yes - you get to write off interest on taxes, and yes - you do not write off principal payments. But you don't pay interest on equity. So if you have a home worth $100k- say your two options are a $100,000 interest-only mortgage @ 5% (would maximize interest vs principal) or no mortgage. And say you're in the 25% bracket...

The rental income would be the either way, so it doesn't matter, but:

Mortgage, you'd pay $5000 in interest, and write that off on taxes to save $1250. Net Loss = $3750.
Paid for rental: you'd pay $0 in interest, and write off $0 to save $0 on taxes. Net loss = $0

Losing $0 is better than losing $3750.

If the property is damaged, you have the same risk either way. The amount of loan held against a property has no impact on its market value. If the property is damaged, you lose the same either way. Get homeowner's insurance

But if the property is vacant - there is actual risk with a mortgage, and no real risk with a paid for property. You still have to make the mortgage payment if it's vacant, so the impact of vacancy is magnified when there is a loan.

Loans make leverage. Leverage increases risk.

fuzzy math again IMO
I think the numbers you are comparing are not realistic (most people don't have that choice)

Renting is best if property is 100% leveraged or 100% paid for

Example 1- property must be leveraged because its not paid for

If home was worth 100k and rent was $1k per month
I am suggesting payment on a 100k mortgage is $600/mo with principal or $500/mo without... this PC does not have my amortization tables on it, but I know those numbers are close.

the choices for example 1:
$600 mortgage payment with P+I
or a $500/mo mortgage payment with just interest

In those two situations there is either $4800 profit (P+I) or $6000 (I) profit on the rent.
In both those situations the $6000 of mortgage interest is deductable- so $1500 is the tax benefit in both cases (granted the interest rate on interest only is higher, but probably not enough to change this significantly)

I would rather have $7500 profit than $5300 profit

Example 2
If house was paid for, and the $1000/mo rent above was all cash, then I do agree that $12,000 profit in rent is better than $7500.

So conclusion- if property is not close to paid off, pull all money out of property, finance it at 100% and rent using an interest only loan. This does not mean pay nothing to principal, but give owner the option of how much principal is paid down (this could also be done based on depreciation claimed, but we did not include that above and does complicate this a little).

My point is that if a rental unit is financed, its best to NOT have any of rent paying principal, and this is because
a) more profit from rent
b) less risk- if 100k property above was damaged, and insurance did not cover the repairs (think Katrina flood vs homeowners insurance or think if property burned down or tenant damaged property), if I had 20k equity in house, I need to invest resources to recoup my 20k, if I have no equity in property I can walk away with little harm to my bottom line and net worth.
c) keeps rent payment (mortgage payment) cheaper so if the property is vacant, the overhead is less.

[jpg7n16]

fuzzy math again IMO
I think the numbers you are comparing are not realistic (most people don't have that choice)

If I've learned anything from our talks, it is never to trust your math when it comes to loans.

If home was worth 100k and rent was $1k per month
I am suggesting payment on a 100k mortgage is $600/mo with principal or $500/mo without... this PC does not have my amortization tables on it, but I know those numbers are close.

the choices for example 1:
$600 mortgage payment with P+I
or a $500/mo mortgage payment with just interest

In those two situations there is either $4800 profit (P+I) or $6000 (I) profit on the rent.
In both those situations the $6000 of mortgage interest is deductable- so $1500 is the tax benefit in both cases (granted the interest rate on interest only is higher, but probably not enough to change this significantly)

I would rather have $7500 profit than $5300 profit

so 100k mortgage @ 6%. The $500 and $600/month are correct. The rest is off a bit. Because you treat the payments to principal as though they never happened. A reduction in a liability is considered income... ergo profit. Which you would realize upon either a) the sale of the property, or b) the repayment of the outstanding loan (even interest only's have to get paid back sometime).

The $600/month is marginally better, but it's better. Cause you pay $7200 in cash, reduce the loan amount owed by $1,233.56 (the 33.56 over 1200 is due to the decreased loan balance over the course of the year), so you have paid $5,966 in interest and can thus save $1,491 on your taxes.

So $500/month: Take $7200 cash - $6000 paid in interest + $1500 cash saved on taxes = $2700 cash + 0 reduced liability = $2700 left (loss of 4500)
and $600/month: Take $7200 cash - $5,966 interest + 1,491 cash saved on taxes = 1491 cash + 1233 reduced liability = $2724 left (lost of 4476)
or no mortgage: Take $7200 cash - 0 interest + 0 saved on taxes = $7200 cash + 0 reduced liability = $7200 left (loss of $0)

So like I said, the $600 is marginally better - in this case $24 more profit in year one, which will get gradually larger as the mortgage gets closer to $0. Cause obviously $0 mortgage is the best, so the closer you get to $0 mortgage, the better off you'll be.

...So conclusion- ...
a) more profit from rent

Not true. See above.

b) less risk- if 100k property above was damaged, and insurance did not cover the repairs (think Katrina flood vs homeowners insurance or think if property burned down or tenant damaged property), if I had 20k equity in house, I need to invest resources to recoup my 20k, if I have no equity in property I can walk away with little harm to my bottom line and net worth.

Except that with $20k equity, you would only owe the bank $80k.
With $0 equity, you would owe the bank $100k.

Soo what is the difference? Both scenarios just lost $100k because the asset lost 100k. The liabilities still have to get paid off.

Accounting 101: Assets - Liabilities = Equity

So with 20k equity: (Before) $100k home - $80k mortgage = $20k equity; (After) $0k home - $80k mortgage = (80k) Equity; Equity lost $100k

With $0k equity: (Before)$100k home - $100k mortgage = $0k equity; (After) $0k home - $100k mortgage = (100k) equity; Equity lost $100k

Or do you think that if the home is worth $0, you don't owe the bank anymore?? You still owe $100k and you don't have an asset to sell anymore to pay that debt. You'll have to pay it from other assets.

c) keeps rent payment (mortgage payment) cheaper so if the property is vacant, the overhead is less.

Keeps mortgage balance higher, so the interest expense in higher. Interest expense is part of overhead, and will be charged vacancy or not. Thus higher mortgage = higher overhead.

No mortgage = winner

[jIM_Ohio]

Or do you think that if the home is worth $0, you don't owe the bank anymore?? You still owe $100k and you don't have an asset to sell anymore to pay that debt. You'll have to pay it from other assets.

Correct- if you have $0 equity in property, you can walk away from it. That is my point- if you have equity, you might have to spend money to get the equity out. Might damage credit, but you can walk away and not lose any money you put into the property. This assumes you have some legal entities created so the bank cannot tap other assets to pay for original property.

Some examples- you own a rental unit in a decent part of town, then company XYZ closes up shop and moves out- demand goes down for rental units and property values plummet. If you have equity, the only way to get that money (which you originally paid) is to sell the house, fix it up, or live in it yourself.

If you have 0 equity you can literally walk away (you eliminate the risk of the rental demographic changing). If you have 20k equity, you won't get it back.

Exhibit A is Flint Michigan (I have lived there before and when GM pulled out, it got bad fast). Houses which sold for 100k are now selling for 15k. Anyone with 20% into their rental units lost their equity. Anyone which pulled cash out did not have that problem.

Quote:
If home was worth 100k and rent was $1k per month
I am suggesting payment on a 100k mortgage is $600/mo with principal or $500/mo without... this PC does not have my amortization tables on it, but I know those numbers are close.

the choices for example 1:
$600 mortgage payment with P+I
or a $500/mo mortgage payment with just interest

In those two situations there is either $4800 profit (P+I) or $6000 (I) profit on the rent.
In both those situations the $6000 of mortgage interest is deductable- so $1500 is the tax benefit in both cases (granted the interest rate on interest only is higher, but probably not enough to change this significantly)

I would rather have $7500 profit than $5300 profit
so 100k mortgage @ 6%. The $500 and $600/month are correct. The rest is off a bit. Because you treat the payments to principal as though they never happened. A reduction in a liability is considered income... ergo profit. Which you would realize upon either a) the sale of the property, or b) the repayment of the outstanding loan (even interest only's have to get paid back sometime).

The $600/month is marginally better, but it's better. Cause you pay $7200 in cash, reduce the loan amount owed by $1,233.56 (the 33.56 over 1200 is due to the decreased loan balance over the course of the year), so you have paid $5,966 in interest and can thus save $1,491 on your taxes.

So $500/month: Take $7200 cash - $6000 paid in interest + $1500 cash saved on taxes = $2700 cash + 0 reduced liability = $2700 left (loss of 4500)
and $600/month: Take $7200 cash - $5,966 interest + 1,491 cash saved on taxes = 1491 cash + 1233 reduced liability = $2724 left (lost of 4476)
or no mortgage: Take $7200 cash - 0 interest + 0 saved on taxes = $7200 cash + 0 reduced liability = $7200 left (loss of $0)

So like I said, the $600 is marginally better - in this case $24 more profit in year one, which will get gradually larger as the mortgage gets closer to $0. Cause obviously $0 mortgage is the best, so the closer you get to $0 mortgage, the better off you'll be.

I bought some of this, but did not agree with other parts...

As you pointed out paying P+I is "marginally better" your words straight up by the numbers
but the risk on this is MUCH higher than the marginal gain on a balance sheet.

Meaning for extra $1200 per year, you gain $24 per year- most rental units are designed based on cash flow- meaning you want income to exceed expenses, so if I can reduce my cash flow requirement by $1200, and not add much risk, that is a good move.

I am looking at risk adjusted returns, not straight up balance sheet. If you want your $24 extra, then pay principal too.

Quote:

c) keeps rent payment (mortgage payment) cheaper so if the property is vacant, the overhead is less.

Keeps mortgage balance higher, so the interest expense in higher. Interest expense is part of overhead, and will be charged vacancy or not. Thus higher mortgage = higher overhead.

As you pointed out, the expense is not much higher though, and the cashflow footprint is less. The mortgage balance for early part of mortgage is nearly the same- would not be until year 5 or 10 or 15 of the amortization schedule which pays principal to be ahead enough of the interest only schedule to see a significant difference in cash flow. If you planned to hold the property for a long time, then it makes sense to pay down principal, but if rental is short term (like renting until you can sell), then cashing out is a better deal IMO.

I am being coached on rentals from a friend, and it might be something I dive ankle deep into shortly... he cashes out all equity while renting for various reasons- most of it is the risk aspect of it. He does not want $20,000 tied up into a house he will never live in. He never plans to keep the house long enough to pay it off either (he flips them, then rents them until someone will buy it). So in all cases he plans to have the buyer pay off the 100k note, not the owner.

If a person knows they will never pay off the house, paying down principal does not give a good return on cash. If you would do otherwise if you owned a rental, that is OK- its about you managing your risk on an investment you made.

Here are some factors I did not see included in above

1) Whether paying principal or not, you can deduct the depreciation on the property. I am an amateur at this, but If 100k house had $1200 paid to principal or $0 paid to principal, I can deduct the same annual depreciation (because the depreciation is based on 100k value, not the balance due). I would have to examine the tax return to be sure, but I believe this is where not paying principal helps-

A seller is required to identify depreciated value when asset is sold (so if property is held for 3 years, sller must show 3 years depreciation on asset whether seller claimed it in prior years or not). The seller is taxed on this gain at time of sale. What I need to see is if paying down principal changes this equation (I have not done that math yet).

If property was 100k value, and 3 years depreciation is 25k (I realize that's a SWAG) I am taxed on the 25k I claimed prior years depreciation. I don't see how paying principal affects this as I type, but I am not looking at the tax code either right now

2) Often the 20k pulled out would be used (partially) as cash to purchase another unit to flip- reducing overall risk (better to have 3-4 units which might be 66% or 75% utilized than to have all money tied up in one unit which is either 0% or 100% utilized. Again this is a risk thing, not focusing on the price or equity in any single unit.
3) Most of this equation for me is focused on 2-3 things
a) the money I put down to acquire property (in my case it would be 5k-10k depending on if friend and I went 50-50 or 100%, and fact we are getting low priced properties to begin with). In most cases we are looking to acquire fixer uppers which cost 50k where houses might sell for 80k-100k otherwise. 10k is 20% down, then maybe another $1000-$4000 in costs to fix the place up.
b) my measure of success is based on if I put 5k down, the sooner I get my 5k back is less risk. So once property is fixed, getting that money back quickly allows the process to be repeated sooner (hence the desire to cash out max bank will allow).
c) I never intend to own the property 100% and if purchase price was 25k for me and I can get 30k back on the flip, that is success again. More often than not the profit would be higher, but even 5k of profit for 2 months work is not bad.

[jpg7n16]

Correct- if you have $0 equity in property, you can walk away from it. That is my point- if you have equity, you might have to spend money to get the equity out. Might damage credit, but you can walk away and not lose any money you put into the property. This assumes you have some legal entities created so the bank cannot tap other assets to pay for original property.
...
If you have 0 equity you can literally walk away (you eliminate the risk of the rental demographic changing). If you have 20k equity, you won't get it back.

Oh - see I didn't consider "hide your assets and steal from the bank" to be a viable option.

I bought some of this, but did not agree with other parts...

As you pointed out paying P+I is "marginally better" your words straight up by the numbers
but the risk on this is MUCH higher than the marginal gain on a balance sheet.

Meaning for extra $1200 per year, you gain $24 per year- most rental units are designed based on cash flow- meaning you want income to exceed expenses, so if I can reduce my cash flow requirement by $1200, and not add much risk, that is a good move.

I am looking at risk adjusted returns, not straight up balance sheet. If you want your $24 extra, then pay principal too.

If you just walk away and stiff the bank without paying your loan, then yes this is true. If you're not going to pay back what you owe, then yeah there's no real risk.

But if you wanted to do the honest thing, each $100 applied towards interst is like $100 invested at 6% * (1-tax rate) guaranteed for the life of the loan. You'll save marginally more in year 1, and will also save 6% * (1-.25) * 1200 = $54 per year for the remainder of the loan period. Over 30 years, the extra 1200 in year 1 would have saved $1,590 over the interest-only option, and you could recoup your initial 1200 by selling the property.

It's marginal because it's only $100/month.

...I am being coached on rentals from a friend, and it might be something I dive ankle deep into shortly... he cashes out all equity while renting for various reasons- most of it is the risk aspect of it. He does not want $20,000 tied up into a house he will never live in. He never plans to keep the house long enough to pay it off either (he flips them, then rents them until someone will buy it). So in all cases he plans to have the buyer pay off the 100k note, not the owner...

Your friend is taking higher risk to make profit. Instead of using his additional cash to save on interest at say 5%, he's trying to reinvest it into a highly leveraged property to make more than 5%. It's a higher risk he's taking. He's perpetually borrowing at 5% to (hopefully) invest it and return higher than that.

You could do the same thing by getting a home equity loan for the entire value of your home and investing it all into the stock market. You would attempt to pay 5-6% on the HEL, in order to make 9-12% in the stock market. It's an option, but it's risky.

Instead of investing the cash into the stock market, your friend is reinvesting the cash into flipping rental properties.

It seems like so far it's been working for him, and for his sake, I hope it continues to.

If property was 100k value, and 3 years depreciation is 25k (I realize that's a SWAG) I am taxed on the 25k I claimed prior years depreciation. I don't see how paying principal affects this as I type, but I am not looking at the tax code either right now

The mortgage has no effect on depreciation write-offs. Like you said, they're based on the value of the home, not the balance of the mortgage. So $0 mortgage and 100% mortgage get the same depreciation expense.

When you sell the home, you are selling an asset with a basis. You have to recapture depreciation (if selling for more than the depreciated basis) regardless of how you originally paid for the asset (mortgage or cash).